6.3.1.1 Definition of economic loss and realised LGD

For the purpose of LGD estimation as referred to in Article 181(1)(a) of Regulation (EU) No 575/2013, institutions should calculate realised LGDs for each exposure, as referred to in point (55) of Article 4(1) of that Regulation, as a ratio of the economic loss to the outstanding amount of the credit obligation at the moment of default, including any amount of principal, interest or fee.

For the purpose of paragraph 131, institutions should calculate the economic loss realised on an instrument (i.e. defaulted facility), as referred to in point (2) of Article 5 of Regulation (EU) No 575/2013 as a difference between:

• (a) the outstanding amount of the credit obligation at the moment of default, without prejudice to paragraph 140, including any amount of principal, interest or fee, increased by material direct and indirect costs associated with collecting on that instrument discounted to the moment of default; and
• (b) any recoveries realised after the moment of default discounted to the moment of default.

For the purpose of calculation of the economic loss realised on an exposure in accordance with paragraph 132 institutions should take into account all realised recoveries including the recoveries from unknown sources and recoveries related to collaterals that do not meet the requirement of Article 181(1)(f) of Regulation (EU) No 575/2013.

Where, relating to a default event, any part of exposure has been forgiven or written off before or at the date of default and the amount forgiven or written off is not included in the outstanding amount of the credit obligation at the moment of default the amount of the exposure that was forgiven or written off should be added to the outstanding amount of the credit obligation at the moment of default for both the calculation of economic loss as specified in paragraph 132 in the numerator, and the calculation of the outstanding amount of credit obligation in the denominator of the realised LGD.

In the case of exposures that return to non-defaulted status, institutions should calculate economic loss as for all other defaulted exposures with the only difference that an additional recovery cash flow should be added to the calculation as if a payment had been made by the obligor in the amount that was outstanding at the date of the return to non-defaulted status, including any principal, interests and fees (‘artificial cash flow’). This artificial cash flow should be discounted to the moment of default in the same manner as all observed cash flows. Where the exposures meet the criteria of paragraph 101, the realised LGD should be calculated with the reference to the date of the first default event taking into account all cash flows observed from the date of the first default event, including those observed during the period between the first and the second defaulted status, without adding any artificial cash flows.

Where institutions open new facilities to replace previously defaulted facilities as part of restructuring or for technical reasons, they should calculate the realised LGDs based on the originally defaulted facilities. For this purpose, institutions should have a sound mechanism to allocate observed costs, recoveries and any additional drawings to original facilities.